Beyond The Buyback Bull?

Thomas Franck of CNBC reports, A force is about to return to the stock market that could ‘chase equities higher’:
The largest public companies in the United States will continue to repurchase their own equity well into 2019 and goose the broader stock market higher, according to J.P. Morgan and Canaccord Genuity.

It’s expected that S&P 500 companies will execute some $800 billion in buybacks and return an additional $500 billion through dividends in 2019, J.P. Morgan’s chief U.S. equity strategist, Dubravko Lakos-Bujas, told clients Friday.

“Despite the recent market volatility, buyback activity has been very strong during the fourth quarter and we expect it to remain robust in 2019 given profit growth, lower valuation, and a record high $700 billion available to execute under existing authorizations,” Lakos-Bujas wrote in a note Friday.

And while the J.P. Morgan strategist acknowledged a more attractive leverage spread, he added that the brokerage still expects the upcoming corporate buybacks to be funded principally by cash flow and balance sheet cash.

“Buyback executions in 2018 have been some of the highest quality of this cycle as they have been predominantly funded by cash rather than debt, a trend we expect to persist into 2019,” Lakos-Bujas wrote. “If volatility remains elevated, corporates are likely to opt for buybacks over M&A and dividend growth.”

J.P. Morgan’s early call for persistent buyback strength came with the 2018 fourth-quarter earnings season in full swing. More than 20 percent of S&P 500 companies have already reported results, with more than 70 percent of the group topping Wall Street’s profit expectations.

J.P. Morgan expects a lot of upside for the domestic market in 2019. Its S&P 500 price target is 3,000 for the full year, a more than 13 percent gain from the current level.

Buyback window

But even if companies did want to charge ahead with buybacks, some would have likely have to stall following their earnings announcement.

The Securities and Exchange Commission established rules governing the conditions under which companies can buy back their own shares. Corporations cannot do so at the end of the trading day (in the last 10 minutes), they have to use a single broker for the trades, they have to buy shares at the prevailing market price, and they can’t be more than 25 percent of the average trading volume over the previous four weeks.

Further, company executives may have access to inside information, particularly in the period when they are gathering corporate financial information immediately before an earnings report. Most publicly traded companies have predetermined blackout periods that restrict trading in shares prior to and immediately after the company reports earnings as to avoid the appearance of insider trading.

So as more and more companies report, Wall Street trading desks will get the green light to buy again for corporate clients.

“The most advantageous time for buyback desks to put money to work is shortly after a correction has concluded,” wrote Canaccord Genuity’s Brian Reynolds. “Equity prices are near the point where those desks would likely begin to feel pressure to chase equities higher, as has happened after every major correction in the modern shadow banking era.”

Reynolds did note, however, that some companies may be tempted to wait for a pullback instead of chasing stocks higher. The strategist recalled the equity action one year ago, when a brief pullback in February was resolved with the help of buyback desks chasing stocks higher for four months thereafter.

So while companies may haggling over the timing, the decision to repurchase will have to be made at some point soon.

“If they wait too long and buy above the average, they are viewed by their clients as adding increasingly less value,” Reynolds wrote. Canaccord Genuity also sees big upside for the S&P 500 over the next 11 months with a year-end target of 2,950, representing 11 percent upside from current levels.
In November, I wrote a comment looking at whether the buyback bull is back, noting the following:
[...] there's no doubt that shares buybacks help markets at the margin but I think some analysts and strategists overestimate the effects of buybacks as if they're the end all and be all of the stock market.

They're not. They're part of the market and people should understand what drives them and what happens during a recession.

The two more important factors weighing on stocks right now are rising rates and a hawkish Fed sending the US dollar to a 16-month high and wreaking havoc on emerging markets stocks (EEM) and many other Risk On assets like biotech shares (XBI) and other momentum plays.

[...] Marko Papic, Chief Strategist, Geopolitics at BCA Research shared this on LinkedIn (click on image):

The key passage is this:
What is the investment implication of the Democrats' sweep in the Midwest? President Trump won over many blue collar "Obama-Trump" voters in 2016 by appealing to their belief that free trade was unfair. If Trump plans to outperform with these voters again in 2020, he may have to double-down on trade war in the next 12 months.
If that happens at a time when the Fed is hell bent on raising rates, committing a major policy blunder in the process, we are in for quite a storm for global risk assets.
Well, we all know what happened next, the Fed Grinch stole Christmas and we had a Christmas Eve massacre which sent everyone scrambling before the big buyers came back on Boxing Day to make stocks great again.

Big companies like Apple lost billions buying back shares in the last quarter of 2018. Others didn't fare any better.

The reason? Well, buybacks might sound impressive in terms of total dollars and they most certainly help at the margin, but when you have massive hedge fund and mutual fund redemptions in Risk Off markets, like we did in Q4 2018, companies repurchasing their shares get cooked along with everyone else.

There's always some strategist on Wall Street talking up buybacks but I would caution you to be careful and not read too much into this activity.

A more interesting article appeared earlier this morning when CNBC's Jeff Cox reported the Fed may be moving closer to ending its rally-killing balance sheet reduction:
Federal Reserve officials are nearing a decision on when to end the reduction of the bonds it is holding on its balance sheet, a key consideration for investors watching how far the central bank will go in tightening monetary policy, according to The Wall Street Journal.

The Fed began the balance sheet roll-off in October 2017 after it had reached more than $4.5 trillion. Wall Street has worried that the operation is adding to market pressure stemming from a series of interest rate hikes that began in 2015.

Further consideration of when to end the roll-off is likely to come up at next week’s Federal Open Market Committee meeting, according to the report. The policymaking body has been weighing the balance sheet reduction during its last several meetings, with officials noting in December that the central bank’s benchmark funds rate could become volatile as the operation proceeds.

“A lot of the heavy lifting has been done,” Kansas City Fed President Esther George told the Journal in a Jan. 15 interview. “We’re waiting for the committee to be satisfied that they have reached sufficient understanding of what all the moving pieces are.”

The Fed has been reducing its balance sheet by allowing a set level of proceeds from the bonds to roll off each month, while the rest has been reinvested. The maximum roll-off is $50 billion a month, though it is rarely, if ever reached — December saw about a $34 billion reduction in the Treasurys and mortgage-backed securities that are involved in the program. In total, the bond reduction has been about $400 billion.

The central concern is what level of reserves the banking system is comfortable holding. A higher level of reserves in the system corresponds with a higher balance sheet, meaning the Fed could curtail the roll-off earlier than expected.

While Fed officials initially thought the balance sheet reduction could be done with little disturbance to markets, that hasn’t been the case. Stocks opened higher Friday, though it wasn’t clear whether the Journal’s report was feeding into the positive sentiment.

Regardless, Wall Street is likely to be relieved at indications that the end could be near for the balance sheet reduction. Markets have reacted negatively at various points to balance sheet news, with a sell-off in December after Fed Chairman Jerome Powell said the operation was running smoothly and likely would not be changed.

“In our view this is the natural play for the Fed, which had to abandon the position that the balance sheet is on autopilot after the adverse market reaction in December but remains unconvinced by theories that [quantitative tightening] is causing an outsized tightening of financial conditions via liquidity channels,” Krishna Guha, head of global policy and central bank strategy team at Evercore ISI, said in a note reacting to the Journal report.

Guha said he does not anticipate an imminent announcement from the Fed on where it will take the balance sheet, with expectations that the issue will be resolved over the March-to-June period. He expects the final size to be around $3.5 trillion, or about $600 billion less than the current level.

Indeed, officials at the December meeting discussed how to communicate the complicated issue to the public.

The balance sheet expansion happened during three rounds of bond buying that began during the financial crisis and continued as the economy continued to expand at a sluggish pace. The purchases ultimately ended in October 2016, and the roll-off started a year later.
Nothing juices stocks and other risk assets more than talk that the Fed is about to end or significantly curb its balance sheet reduction program.

I'll put it this way, if it's between buybacks or curbing the Fed's balance sheet reduction, the latter is far more important for stocks to move higher. It's not even close.

Of course, the two are interrelated because as long as the Fed doesn't hike rates or continue reducing its balance sheet, high yield spreads won't blow up (hopefully) and companies can continue borrowing at a record pace to buy back shares (to manipulate earnings per share and justify senior managers' bloated compensation).

Anyway, as Michael Sheetz reports, the Dow gained for fifth straight week after deal reached to temporarily reopen government:
U.S. stocks rose on Friday as investors looked past a poor Intel earnings report, instead focusing on a partial government shutdown solution.

President Donald Trump announced that he reached a continuing resolution deal with Congress to reopen the U.S. government. The temporary deal will fund the government for three weeks until Feb. 15.

The Dow Jones Industrial Average closed higher by 184 points, or 0.8 percent, to 24,737.20. The S&P 500 also rose nearly 1 percent, while the Nasdaq Composite moved higher as constituent Starbucks gained on strong earnings.

The Dow squeaked out a weekly gain of 0.1 percent for the week, its fifth straight positive week as investors continued to buy after the market’s big December drop. That five week win streak was the Dow’s longest since August.

“For the government to be open, for both sides to be talking – has got to be a positive for Wall Street. Everyone agreed there was measurable economic damage each week,” Tom Block, Washington policy strategist at Fundstrat Global Advisors, told CNBC.

Apple, Amazon Alphabet and Facebook led the gains as investors got back into a risk-taking mood with the shutdown ending, buying their favorite technology names. Apple jumped 3.3 percent.

Additionally, two other themes added positive sentiment to Friday’s trading: Federal Reserve monetary policy and trade negotiations with China.

The Wall Street Journal reported that the Fed is closer than expected to ending its balance sheet unwind. The Fed’s decision is a key consideration for investors as they gauge the extent to which the central bank will tighten its monetary policy. .

Treasury Secretary Steven Mnuchin projected confidence about the status trade negotiations between the U.S. and China in comments to Reuters. Mnuchin said both sides were “making a lot of progress” in the talks.

Major indexes pared their gains slightly after Trump made the official announcement the government would temporarily re-open, as some traders were disappointed that it wasn’t a more comprehensive agreement.

“We’ve become conditioned to the D.C. dysfunction. Traders will take profits and prepare themselves for additional stalemates,” Jeff Kilburg, CEO of KKM Financial, told CNBC.

Intel reported fourth quarter earnings which beat Wall Street expectations but missed on revenue. The company’s 2019 forecast showed revenue growth of just 1 percent, with Intel expecting to report first quarter earnings of 87 cents a share – 14 cents below Wall Street expectations. Intel continues to search for a new CEO, seven months after Brian Krzanich was forced out. The stock was down more than 7 percent in trading, but other chip stocks were holding steady.

Starbucks stock gained as the company reported strong sales and earnings growth for its first quarter report. The coffee giant saw revenue climb 9 percent compared to the same period last year.

The government shutdown took on a new phase of seriousness Friday as the FAA halted some flights at New York’s LaGuardia airport on Friday because of a shortage of air traffic control workers. Traders are betting that increasing fallout from the shutdown may force Republicans and Democrats to at least come together for a short-term compromise.

The U.S. Senate, after rejecting two shutdown-ending bills, continues to search for a way to end a government closure entering its 35th day. The shutdown was threatening the economy, as hundreds of thousands of federal workers missed a second paycheck on Friday. Trump said federal workers would receive back pay in four or five days.

Investors are also continuing to monitor concerns surrounding a trade deal with China. Markets came under pressure Thursday after Commerce Secretary Wilbur Ross said that trade negotiations with China were far from complete. “We would like to make a deal but it has to be a deal that will work for both parties,” Ross told CNBC. “We’re miles and miles from getting a resolution.”

Mnuchin’s comments about progress in the trade talks came a few hours after Ross spoke. The Treasury secretary said he is looking forward to speaking with Chinese Vice Premier Liu He next week, when the representative visits the U.S.
It's always the same themes, trade tensions with China, the government shutdown, the Fed, Brexit, etc. and investors are looking for some reprieve so stocks can move higher.

Below, a ranking of the top S&P sectors this week (click on image):


As you can see, Real Estate (+1.5%), Information Technology (+1.00%) and Utilities (+0.4%) gained on the week while the other sectors registered declines, so it wasn't a great week.

Year-to-date, however, we see a different picture thus far, with cyclical sectors like Energy (XLE), Financials (XLF), Industrials (XLI) and Consumer Discretionary (XLY) all leading the charge higher (click on image):


If cyclical sectors continue outperforming for the rest of the year, it could be a great year for stocks.

But I caution everyone, it's only been a month, January isn't over yet and the big bounce in cyclicals was to be expected after they got killed in December.

In other words, don't read too much into the buyback bull or this big bounce in cyclicals, the reduction in the Fed's balance sheet might help down the road, especially if the US economy continues to slow which it will. For more details on my macro and market thoughts, read last week's comment on reassessing the rebound in markets.

Below, Howard Silverblatt, senior industry analyst for the S&P Dow Jones Indices, discusses how stock buybacks surpassed $200 billion for the first time in a quarter.

Second, Charlie McElligott, cross-asset macro strategist for the Americas at Nomura, joins "Squawk Box" with a breakdown of his latest calls.Very interesting views, listen to his insights as he looks carefully at positioning to make his calls.

And lastly, the most important market interview of the week. Greg Jensen, co-chief investment officer at Bridgewater, discusses current market structure and the firm's economic outlook, monetary policy, and earnings expectations. He spoke with Bloomberg's Erik Schatzker at the World Economic Forum's annual meeting in Davos, Switzerland, on "Bloomberg Surveillance."

Before you get too excited about buybacks and the reduction in the Fed's balance sheet, listen to Greg Jensen explain why they remain cautious this year.

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